When Did You Last Review Beneficiary Designation Forms?

For many people, naming beneficiaries occurs when they first set up an account, and it’s rarely given much thought after that. The Street’s recent article entitled “Secure your IRA – Review Your Beneficiary Forms Now” says that many account holders aren’t aware of how important the beneficiary document is or what the consequences would be if the information is incorrect or is misplaced. Many people are also surprised to hear that wills don’t cover these accounts because they pass outside the will and are distributed pursuant to the beneficiary designation form.

If one of these accounts does not have a designated beneficiary, it may be paid to your estate. If so, the IRS says that the account has to be fully distributed within five years if the account owner passes before their required beginning date (April 1 of the year after they turn age 72). This may create a massive tax bill for your heirs.

Get a copy of your listed beneficiaries from every institution where you have your accounts, and don’t assume they have the correct information. Review the forms and make sure all beneficiaries are named and designated not just the primary beneficiary but secondary or contingent beneficiary. It is also important tomake certain that the form states clearly their percentage of the share and that it adds up to 100%. You should review these forms at any life change, like a marriage, divorce, birth or adoption of a child, or the death of a loved one.

Note that the SECURE Act changed the rules for anyone who dies after 2019. If you don’t heed these changes, it could result in 87% of your hard-earned money to go towards taxes. For retirement accounts that are inherited after December 31, 2019, there are new rules that necessitate review of beneficiary designations:

  1. The new law created multiple “classes” of beneficiaries, and each has its own set of complex distribution rules. Make sure you understand the definition of each class of beneficiary and the effect the new rules will have on your family.
  2. Some trusts that were named as beneficiaries of IRAs or retirement plans will no longer serve their original purpose. Ask an experienced estate planning attorney to review this.
  3. The stretch IRA has been eliminated for most non-spouse beneficiaries. As such, most non-spouse beneficiaries will need to “empty” the IRA or retirement account within 10 years and they can’t “stretch” out their distributions over their lifetimes. Failure to comply is a 50% penalty of the amount not distributed and taxes due.

For many, the beneficiary form is their most important estate planning document but the most overlooked.

Reference: The Street (Dec. 28, 2020) “Secure your IRA – Review Your Beneficiary Forms Now”

Why Is a Roth IRA a Perfect Supplement to Social Security?

The average monthly Social Security is a little more than $1,500. It wasn’t designed to sustain seniors without other income.

Tucson.com’s recent article entitled “3 Reasons a Roth IRA Is a Perfect Supplement to Social Security” reminds us that it’s important to line up some additional income streams outside of those benefits. A good one to look into is a Roth IRA, and here’s why.

  1. You’re able to fund a Roth IRA at any age. Many seniors choose to work in retirement, either to make some more money or to give themselves something to do with their free time. If you go this route, you’ll have the option to put those earnings into a Roth IRA. You can contribute to a Roth IRA at any age. Therefore, if you decide to work more for the purpose of alleviating boredom and don’t need your full paychecks to live on, you can save that money and allow it to enjoy tax-free growth.
  2. Withdrawals won’t trigger taxes on your Social Security benefits. If Social Security is your only source of retirement income, you’ll probably collect your benefits in full without being subject to federal taxes. However, if your earnings exceed a certain threshold, there are taxes on Social Security income. To determine whether you’ll have taxes on your Social Security benefits, you’ll need to calculate your provisional income (your non-Social Security income plus half of your yearly benefit). You could be taxed on up to 50% of your benefits if you earn between $25,000 and $34,000 as a single tax filer, or between $32,000 and $44,000 as a married couple filing a joint return. iI your provisional income goes beyond $34,000 as a single tax filer or $44,000 as a joint filer, you could be taxed on up to 85% of your benefits. Any Roth IRA withdrawals from that account won’t count toward your provisional income. That might also leave you with more money from Social Security.
  3. Flexibility. The Roth IRA is the one tax-advantaged retirement savings account that doesn’t have required minimum distributions, or RMDs. That allows you considerable flexibility with your money. You can let your account sit there, while your money enjoys tax-free growth. You can also leave some money to your heirs, if that’s something you can afford to do.

Plan on having access to some retirement income outside of Social Security. While that income doesn’t have to come from a Roth IRA, it pays to open one and contribute steadily during your career. A Roth IRA won’t give you an immediate tax break, but your contributions will be made with after-tax dollars. Therefore, the benefits you stand to gain in retirement more than make up for that.

Reference: Tucson.com (Oct. 5, 2020) “3 Reasons a Roth IRA Is a Perfect Supplement to Social Security”

Do I Qualify as an Eligible Designated Beneficiary under the SECURE Act?

An eligible designated beneficiary (EDB) is a person included in a unique classification of retirement account beneficiaries. A person may be classified as an EDB, if they are classified as fitting into one of five categories of individuals identified in the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The bill passed in December 2019 and is effective for all inherited retirement accounts, as of the first of this year.

Investopedia’s recent article entitled “Eligible Designated Beneficiary” explains that these people get special treatment and greater flexibility to withdraw funds from their inherited accounts than other beneficiaries.

With the SECURE Act, there are now three types of beneficiaries. It is based on the individual’s connection to the original account owner, the beneficiary’s age, and his or her status as either an individual or a non-person entity. However, an EDB is always an individual. On the other hand, an EDB can’t be a trust, an estate, or a charity, which are considered not designated beneficiaries. There are five categories of individuals included in the EDB classification. These are detailed below.

In most instances, except for the exceptions below, an EDB must withdraw the balance from the inherited IRA account over the beneficiary’s life expectancy. There is optional special treatment allowed only for surviving spouses, which is explained below. When a minor child reaches the age of majority, he or she is no longer considered to be an EDB, and the 10-year rule concerning withdrawal requirements for a designated beneficiary applies.

Here are the five categories of EDBs.

Owner’s surviving spouse. Surviving spouses get special treatment, which lets them step into the shoes of the owner and withdraw the balance from the IRA over the original owner’s life expectancy. As another option, they can roll an inherited IRA into their own IRA and take withdrawals at the point when they’d normally take their own required minimum distributions (RMDs).

Owner’s minor child. A child who isn’t yet 18 can make withdrawals from an inherited retirement account using their own life expectancy. However, when he or she turns 18, the 10-year rule for designated beneficiaries (who aren’t EDBs) applies. At that point, the child would have until December 31 of the 10th year after their 18th birthday to withdraw all funds from the inherited retirement account. A deceased retirement account owner’s minor child can get an extension, up until age 26, for the start of the 10-year rule, if he or she is pursuing a specified course of education.

An individual who is disabled. The tax code says that an individual is considered to be disabled if he or she is “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long continued and indefinite duration.” A disabled person who inherits a retirement account can use their own life expectancy to calculate RMDs.

An individual who is chronically ill. The tax code states that “the term ‘chronically ill individual’ means any individual who has been certified by a licensed healthcare practitioner as—

  • being unable to perform (without substantial assistance from another individual) at least two activities of daily living for a period of at least 90 days, due to a loss of functional capacity,
  • having a level of disability similar (as determined under regulations prescribed by the Secretary in consultation with the Secretary of Health and Human Services) to the level of disability described in clause (i), or
  • requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment.”

A chronically ill individual who inherits a retirement account can use their own life expectancy to determine the RMDs.

Any other person who’s less than 10 years younger than the decedent. This is a catch-all that includes certain friends and siblings (depending on age), who are identified as beneficiaries of a retirement account. This also excludes most adult children (who aren’t disabled or chronically ill) from the five categories of EDBs. A person in this category who inherits a retirement account is permitted to use their own life expectancy to calculate RMDs.

Reference: Investopedia (June 25, 2020) “Eligible Designated Beneficiary” 

How Should I Take My Pension?

The number of pension plans decreased to just 46,700 in 2017, from 103,000 in 1975. At the same time, defined-contribution plans, such as the 401(k) grew to 662,800, from 207,700, says CNBC’s recent article entitled “Pandemic creates pension plan tension: Take the lump sum or trust lifetime payments.”

With so many companies trying to regain their financial footing in the coronavirus pandemic, a retiring employee’s decision to take either a lump sum or lifetime payments from their pension might end up in one simple question: whether they believe that the company will be able to meet its long-term commitments. It’s one of the primary considerations that employees have, when doing this kind of analysis.

A tricky part of making a decision about how to receive your pension benefits is that retirees typically like the idea of guaranteed income for life, which makes electing continuing payments more appealing than a lump sum.

If you want to stay on as a plan participant, make sure you have confidence in the company’s ability to make those future payments. While the federal Pension Benefit Guaranty Corporation (PBGC) would step in if the company failed to meet its obligations, it may pay only a portion of promised benefits.

If you’re thinking about a lump sum, due to fear of your employer folding or otherwise struggling to meet its pension obligations, know that the amount offered is usually less in comparison to the amount you’re promised to get, over time, if you were to stay in the plan. However, because interest rates are generally low, lump sum offers have been bigger than they’d be if rates were high. Consequently, when interest rates go up, the guaranteed-income option is higher, and the lump sums go down.

If you opt to remain in the pension plan rather than taking the lump sum, the amount you’ll get may be fixed for life, because pensions typically don’t have a cost-of-living adjustment. While some pensions offer spousal benefits (when you die, your spouse would continue getting a continuing, but reduced amount of your payments), there’s nothing left for heirs. Therefore, death ends the plan’s obligations to you, your family and your heirs.

Alternatively, if you take the lump sum, you might have some money remaining at the end of your life that could be left to non-spousal heirs.

Any decision should be made with regard for the rest of your financial plan. It is worth making certain you believe in the company’s long-term viability. The counsel of an experienced financial advisor should be sought when evaluating your options.

Reference: CNBC (June 8, 2020) “Pandemic creates pension plan tension: Take the lump sum or trust lifetime payments”

Social Security Issues, if You’re Self-Employed

Did you know that when you’re self-employed, you’re thought of by the IRS as both the employee and the employer? Therefore, it’s your job to withhold Social Security from your earnings—contributing the employer’s matching portion of Social Security and the individual’s portion. Instead of withholding Social Security taxes from each paycheck and, because many self-employed people don’t get regular paychecks, you pay all the Social Security taxes on your earnings, when you file your annual federal income tax return. This is both your personal contribution and your business’ contribution.

Investopedia’s recent article entitled “How Social Security Works for the Self-Employed” explains how to calculate the Social Security taxes you owe, if you’re self-employed.

IRS Schedule SE is where you report your business’ net profit or loss as calculated on Schedule C. The federal government uses this information to calculate the Social Security benefits you’ll be entitled to in the future. Self-employment tax consists of both the employee and employer portion of Social Security (6.2% + 6.2% = 12.4%), as well as the employee and employer portion of Medicare (1.45% + 1.45% = 2.9%). Therefore, the total the self-employment tax rate is 15.3%.

If you are self-employed, what you pay in Social Security taxes is derived from your net income. On Schedule SE, you multiply your business’ net profit or loss as calculated on Schedule C by 92.35%, then you see how much self-employment tax you owe.

Note that the CARES (Coronavirus Aid, Relief, and Economic Security) Act lets employers defer employee Social Security taxes through Dec. 31, 2020—50% of the deferred amount will be due Dec. 31, 2021, and the other half by Dec. 31, 2022. Good news: this break also applies to the self-employed.

There are many business expenses that the self-employed can use to decrease their tax liability, in addition to the Social Security tax deductions you can take when you’re self-employed. Business expenses reduce your overall tax, which ultimately lowers your Social Security taxes. These tax deductions are a way of minimizing self-employment tax and Social Security taxes. However, you should know that this can be a negative as far as your Social Security benefit calculations. That’s because these are based in part on your taxable earnings. The more deductions you have, the lower your Schedule C income. Lowering your Schedule C income is a good way to reduce how much federal, state, and local income tax you owe, but that lower amount will be part of your Social Security earnings history. As a result, you may receive lower benefits in retirement, than if you didn’t take those deductions.

There’s no Social Security taxes on your wages that exceed a certain earnings threshold. The wage base for 2020 is $137,700 (up from $132,900 in 2019), and you don’t owe Social Security taxes on your earnings that are greater than that amount.

Social Security really isn’t much different whether you’re self-employed or work for someone else. Self-employed individuals earn Social Security work credits the same way employees do and qualify for benefits based on their work credits and earnings. It’s the business tax deductions that are the biggest difference. If you work for someone else, you pay Social Security taxes on all of your earnings, up to the $137,700 limit in 2020. However, if you work for yourself, deductions you claim on Schedule C can make your taxable income substantially lower. That may decrease your Social Security taxes today, but also may decrease your Social Security benefits later.

Reference: Investopedia (April 29, 2020) “How Social Security Works for the Self-Employed”

How Do Farmers Start an Estate Plan?

The Bangor Daily News explains in its article “How farmers can start an estate plan” that we all know we’re going to die, but it’s not our favorite thing to talk about. However, it’s important to start these conversations.

The article helps aging farmers who want to get started with the estate planning process, by sharing some tips to clear up some of the confusion, eliminate questions in the process and motivate you to begin your estate planning journey.

One expert described the process as a business transition. It is not unlike retirement decisions that somebody might make for a job. However, it is much more complicated, because there are many more resources to address (and perhaps many more people).

Clearly defined goals will make that transition much easier for everyone involved. Memorialize your goals by writing them down, along with your dreams for the transfer of the farm. Don’t forget to include your fears.

A basic estate plan can be as simple as a will, a medical directive and a power of attorney. Work with an experienced estate planning attorney to facilitate the various elements of estate planning.

Make a complete inventory of all assets you own, including the deeds to all the tracts of land in your possession.

Identify a successor, so you know who will take over the farm when you die. It’s essential to ensuring the longevity of the farm business you worked so hard to create. As far as transferring your assets in family farm businesses, inter-generational politics can be dicey, when it comes to estate planning. It really boils down to the succession of your farm from one generation to another.

You must be certain to do this in an orderly way to make sure the needs of both generations are met.

If you don’t have a family member interested in taking over the farm, there are local agencies that can help you find young farmers to whom you can sell and who would be able to take over the business.

When it comes to estate planning, it is never too early to begin.

Reference: Bangor Daily News (March 5, 2020) “How farmers can start an estate plan”

What Exactly Is the Estate Tax?

In the U.S., we treat the estate tax and gift tax as a single tax system with unified limits and tax rates—but it is not very well understood by many people. The Motley Fool’s recent article entitled “What Is the Estate Tax in the United States?” gives us an overview of the U.S. estate and gift tax, including what assets are included, tax rates and exemptions in 2020.

The U.S. estate tax only impacts the wealthiest households. Let’s look at why that’s the case. Americans can exempt a certain amount of assets from their taxable estate—the lifetime exemption. This amount is modified every year to keep pace with inflation and according to policy modifications. This year, the lifetime exemption is $11.58 million per person. Therefore, if you’re married, you and your spouse can collectively exclude twice this amount from taxation ($23.16 million). To say it another way, if you’re single and die in 2020 with assets worth a total of $13 million, just $1.42 million of your estate would be taxable.

However, most Americans don’t have more than $11.58 million worth of assets when they pass away. This is why the estate tax only impacts the wealthiest households in the country. It is estimated that less than 0.1% of all estates are taxable. Therefore, 99.9% of us don’t owe any federal estate taxes whatsoever at death. You should also be aware that the lifetime exemption includes taxable gifts as well. If you give $1 million to your children, for example, that counts toward your lifetime exemption. As a result, the amount of assets that could be excluded from estate taxes would be then decreased by this amount at your death.

You don’t have to pay any estate or gift tax until after your death, or until you’ve used up your entire lifetime exemption. However, if you give any major gifts throughout the year, you might have to file a gift tax return with the IRS to monitor your giving. There’s also an annual gift exclusion that lets you give up to $15,000 in gifts each year without touching your lifetime exemption. There are two key points to remember:

  • The exclusion amount is per recipient. Therefore, you can give $15,000 to as many people as you want every year, and they don’t even need to be a relative; and
  • The exclusion is per donor. This means that you and your spouse (if applicable) can give $15,000 apiece to as many people as you want. If you give $30,000 to your child to help her buy their first home and you’re married, you can consider half of the gift from each spouse.

The annual gift exclusion is an effective way for you to reduce or even eliminate estate tax liability. The estate tax rate is effectively 40% on all taxable estate assets.

Finally, the following kinds of assets aren’t considered part of your taxable estate:

  • Anything left to a surviving spouse, called “the unlimited marital deduction”;
  • Any amount of money or property you leave to a charity;
  • Gifts you’ve given that are less than the annual exclusion for the year in which they were given; and
  • Some types of trust assets.

Reference: The Motley Fool (Jan. 25, 2020) “What Is the Estate Tax in the United States?”

How Will the New SECURE Act Impact My IRAs and 401(k)?

The SECURE Act is the most substantial change to our retirement savings system in over a decade, says Covering Katy (TX) News’ recent article entitled “Laws Change for IRA and 401K Retirement Savings Plans.” The new law, called the Setting Every Community Up for Retirement Enhancement (SECURE) Act, includes several important changes. Let’s take a look at them.

There is a higher age for RMDs. The current law says that you must start taking withdrawals or required minimum distributions from your traditional IRA and 401(k) or similar employer-sponsored plan when you turn 70½. The new law delays this to age 72, so you can hold on to your retirement savings a while longer.

No age limit for contributions to traditional IRAs. Before the new law, you could only contribute to your traditional IRA until you were 70½. However, now you can now fund your traditional IRA for as long as you have taxable earned income.

Stretch IRA Limitations. Previously, beneficiaries could stretch taxable RMDs from a retirement account over his or her lifetime. Under the SECURE Act, spouse beneficiaries can still take advantage of this “stretch” distribution, but most non-spouse beneficiaries will have to take all the RMDs by the end of the 10th year after the account owner dies. Therefore, non-spouse beneficiaries who inherit an IRA or other retirement plan could have tax issues, because of the need to take larger distributions in a shorter amount of time.

Early withdrawal penalty eliminated for IRAs and 401(k)s when new child arrives. Usually, you must pay a 10% penalty when you withdraw funds from your IRA or 401(k) if done prior to 59½. However, the new legislation allows you take out up to $5,000 from your retirement plan without paying the early withdrawal penalty, provided you withdraw the money within a year of a child being born or an adoption becoming final.

There are provisions of the SECURE Act that primarily impact business owners, which include the following:

New multi-employer retirement plans. The new law allows unrelated companies to coordinate to offer employees a 401(k) plan with less administrative work, lower costs and fewer fiduciary responsibilities than individual employers now have when offering their own retirement plans.

Tax credit for automatic enrollment. There’s now a tax credit of $500 for some small businesses that create automatic enrollment in their retirement plans. A tax credit for establishing a retirement plan has also been increased from $500 to $5,000.

Annuities in 401(k) plans. The Act makes it easier for employers to add annuities as an investment option within 401(k) plans. Before the SECURE Act, businesses avoided annuities in these plans because of the liability related to the annuity provider. However, the new rules should help decrease any concerns.

Talk to an experienced estate planning attorney to examine the potential impact on your investment strategies and determine any possible tax and estate planning implications of the SECURE Act.

Reference: Covering Katy (TX) News “Laws Change for IRA and 401K Retirement Savings Plans”